The ongoing wave of bank failures related to the financial crisis continues to impact the health of the FDIC's Deposit Insurance Fund (DIF). At the end of the second quarter, the DIF balance was down to $10.4 billion. Compared to a year ago, when the DIF amounted to $45.2 billion, this is a decline of some 77 percent.
As at-risk banks continue to deteriorate, the DIF's growing loss provisions have simply outpaced accrued and collected premiums, including a special assessment that was levied on insured institutions at the end of the second quarter. Rather than demand another special assessment, the FDIC is trying a new tactic to deal with the fund's depletion: prepaid premiums.
According to an FDIC press release, the FDIC Board "has adopted a Notice of Proposed Rulemaking (NPR) that would require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012." The prepayments should generate roughly $45 billion in cash, a much-needed infusion for the anemic DIF.
Numbers game
Time Magazine is calling the tactic "an accounting trick," (http://www.time.com/time/business/article/0,8599,1926877,00.html?iid=tsmodule ) but FDIC Chair Sheila Bair sees it as a necessary step in the fund's restoration. The move won't impact banks' profitability, since they won't recognize the expenses any sooner under prepayment. It will impact liquidity, but the FDIC's position is that banks have sufficient cash to absorb these prepayments.
The push for prepayments underscores the FDIC's commitment to manage through this crisis without asking the Treasury or taxpayers to foot the bill.
Assessment increase ahead
The aforementioned NPR also included an assessment increase of three basis points across the board, to be made effective on January 1, 2011.
Bank Regulators Solicit Comments on Proposed Liquidity Risk Managements
The U.S. federal bank regulators (OCC, FRB, FDIC, OTS) along with the National Credit Union Association (NCUA) have collectively produced a set of guidelines regarding liquidity risk management for financial institutions. The agencies are soliciting public comments on these guidelines through September 4.
The proposed guidelines define a framework for the identification, measurement and monitoring of funding and liquidity risk; they include specific recommendations for:
- corporate governance
- risk mitigation
- management of intraday liquidity
The responsibility of board members
Under the proposed guidelines, an institution's board members are ultimately responsible for managing liquidity risk. The board must therefore establish an appropriate level of risk tolerance for the institution, and then communicate that risk tolerance profile to the internal management team. At least annually, the board should revisit the liquidity strategy to ensure that:
- current liquidity risks are understood
- the liquidity policy is still relevant and appropriate
- the policy is being enforced
- it is clear internally which senior managers are responsible for making liquidity risk decisions
Key aspects of an institution's liquidity plan
The institution's liquidity management plan should:
- be appropriate given the complexity of the institution's structure and activities
- identify primary funding sources, both for daily needs and seasonal or cyclical needs
- define acceptable liquidity strategies, both for expected and unexpected business scenarios
- address liquidity management in terms of separate currencies and/or business lines, where appropriate
- address how the liquidity management practices dovetail with broader business strategies and contingency planning
The plan should establish liquidity projection assumptions and a periodic review process, to ensure that those assumptions continue to be valid over time. Qualitative targets and quantitative objectives should be clearly defined. Examples include:
- Unpledged liquid asset reserve targets
- Funding diversification targets
- Contingent liability exposures
- Desired asset concentrations
- Activity exposures
- Targeted level of unencumbered assets to serve as liquidity cushion
The guidelines also recommend that senior managers receive liquidity reports at least monthly, or more often when economic conditions are severe. Board members should be evaluating the institution's liquidity position at least quarterly.
It is also advised that complex institutions make efforts to build liquidity costs into internal product pricing and performance measurement.
Risk measurement and reporting
Institutions are expected to measure ongoing liquidity risk with short- and long-term cash flow projections that consider both on- and off-balance sheet items. As part of this process, the institution should have measures in place to ensure the appropriate valuation of assets. Other key components of an appropriate liquidity monitoring strategy include:
- regular stress testing
- collateral position management
- procedures to monitor liquidity across business lines and legal entities
- procedures to monitor and manage intraday liquidity position
The report also addresses liquidity risk management practices for holding companies. Read the Proposed Interagency Guidance here and (http://www.fdic.gov/news/news/press/2009/pr09107a.pdf ) let us know what you think. Are these recommended procedures detailed enough to head off unexpected liquidity crises when economic conditions sour? Have the agencies overlooked key liquidity management tactics? Or are these guidelines too much?